7.1 Estimate Project Costs Process

Expected costs for all scheduled activities are established through the Estimate Project Costs process.

The cost estimate is a quantitative assessment of the likely costs for the resources required to complete the activity.

This process occurs at least once, though it's most likely that estimates will undergo several revisions as the planning processes are underway with fewer changes occurring once executing processes begin.

In most organizations, cost estimating is performed by the project manager though for some project types professional estimators may also be involved.

There are several key inputs to this process. The schedule and its associated data containing activity resource requirements and durations form the basis for estimating costs.

The scope statement, WBS, and WBS dictionary are essential to this process because they contain the deliverables, constraints, and assumptions that will have a direct impact on costs.

The human resource plan is also needed because it contains the pay rates and recognition and rewards methods for the project team.

The risk register is also needed because it contains the risk management activities that will be taken to minimize negative risks, and there is a cost involved in those activities.

A solid project budget begins with an accurate and complete inventory of activities, so the cost estimating process is a good place to double-check that all items are accounted for in the scope, WBS, and resource breakdown structure.​

Missing items could trigger scope or schedule change requests if baselines have already been established.

The main outputs of cost estimating are the activity cost estimates and the basis of estimates.

The activity cost estimates contain the expected cost of every project activity, and it is the main source of data for the project funding requirements and the project budget.

The basis of estimates is the supporting detail that provides supplementary information about the activity estimates, such as any assumptions made, constraints, how the estimate was derived, the confidence level in the estimate, and any risk factors that were considered.

Estimate Costs Process Decomposition

Estimate Costs Process Decomposition

Estimate Costs Process: Inputs

  • Scope baseline
    The scope baseline is the approved project scope statement, WBS, and WBS dictionary. These collections provide the deliverables, statements of work, constraints, and assumptions that are necessary for accurate cost estimating.
  • Project schedule
    The project schedule specifies the planned start and finish date for each scheduled activity, and the accompanying schedule data provides the specific activities and resource requirements.
  • Human resource plan
    The human resource plan contains the details on how the project will be staffed, and how the project team will be trained, evaluated, compensated, rewarded, and released from the project. It also contains labor rates, needed for estimating costs, and recognition and rewards programs for the team that must be budgeted for.
  • Risk register
    The risk register is a comprehensive list of all threats and opportunities the project faces. It also contains supplementary data about each risk, including its impact, probability, risk response, budget, risk owner, and contingency and fallback plans. The level of risk inherent in any activity impacts its cost.
  • Enterprise environmental factors
    Factors beyond the project’s boundaries impact costs, including marketplace conditions and the pool of available suppliers.
    Cost estimates for some activities can also use commercially available databases providing standardized estimates based on a number of categories.
  • Organizational process assets
    Lessons learned, project files, and historical information from the organization are crucial for good estimates.
    The organization may also have templates that can be used as starting points.

Estimate Costs Process: Tools and Techniques

  • Expert judgment
    Expert judgment is a form of analogous estimating based upon the experience and knowledge of subject matter experts. It's used to assess and evaluate the inputs and the information they contain.
  • Analogous estimating
    Analogous estimating is a form of expert judgment that uses similar activities from past projects to provide duration or cost estimates.
  • Parametric estimating
    Parametric estimating uses mathematical formulas, usually involving quantity and productivity rates, to determine estimates.
  • Bottom-up estimating
    Bottom-up estimating looks at all the components of an activity in order to provide estimates. These component estimates are then aggregated to derive an estimate for the activity. This is in comparison to top-down estimating, which relies heavily on expert judgment and looks only at the activity at high, overall level.
  • Three-point estimates
    Three-point estimates provide a weighted average that helps level out some of the uncertainty in estimates. Three-point estimates use the optimistic, pessimistic, and most likely estimates.
  • Reserve analysis
    Reserves are time or cost buffers in the project schedule or budget that help the project respond to uncertainties. Reserve analysis monitors these buffers and will use, reduce, or eliminate them based on the current situation.
  • Cost of quality
    The cost of quality quantifies the cost of adhering to the expected level of quality in the deliverables. It is a time and financial determination based on the needed level of quality the deliverable must meet.
  • Project management estimating software
    Software and automated tools can help in developing, simulating, and be reporting on estimated activity costs.
  • Vendor bid analysis
    Vendor bid analysis involves additional techniques to ensure that the bids and work they represent are accurate, reasonable, and acceptable.

Estimate Costs Process: Outputs

  • Activity cost estimates
    Activity cost estimates are a complete accounting of all component costs, such as labor, resources, services, fees, licenses, of a scheduled activity. These can be presented in detail or summary form.
  • Basis of estimates
    The basis of estimates is the supporting detail to the activity cost estimates. What it contains depends upon the project and activity type, but it includes documentation on how the estimate was arrived at, what assumptions were made, what constraints were in place, its range of accuracy, and the confidence level in the estimate.
  • Project document updates
    The process of estimating costs can result in updates to several project documents, including the risk register, WBS, and the WBS dictionary.

Types of Costs

Costs can be classified as direct or indirect, and as either variable or fixed.

Types of Costs

Types of Costs

Direct fixed costs are the most accurate since they can be easily quantified while indirect and variable often have some guesswork involved in how they're estimated, so they are less reliable.

  • Direct costs can be attributed specifically to a detailed or summary activity of the project.
    Direct costs include dedicated labor, material, supplies, equipment, licenses, fees, training, travel, or professional service fees. The defining characteristic for a direct cost is that the goods or services are used exclusively for the project.
  • Indirect costs are incurred by the project, but the goods or services are also used for non-project activities. Common indirect costs might be facility or equipment rentals and utilities. Indirect costs are typically harder to quantify. For example, if a color printer is shared by several project teams, it’s difficult to definitively determine what percentage of costs each should share.
  • Variable costs fluctuate and can't be predicted with absolute certainty. For example, travel or transportation costs that can change depending upon the cost of fuel or certain commodities and types of raw materials.
  • Fixed costs are static throughout the project or have only a small likelihood of fluctuation. Fixed costs are usually for items such as rents, leases, licenses, salaries, and fixed fees.

Major Factors Affecting Costs

Some of the major factors we need to consider while estimating costs are risks, the total cost of ownership, cost of quality, and marketplace conditions.

  • Risks
    During early phases, the greatest risk to budget accuracy is usually that the scope, activity, and constraints aren’t fully known.
    When that’s the case, the basis of estimates (supporting detail to activity cost estimates) should make this clear.
  • Total Cost of Ownership / Life-Cycle
    We saw the relationship between the product lifecycle and the project life cycle.
    The important thing we should have taken away from that discussion is that decisions made within the project impact the product over its entire lifecycle.
    We need to keep in mind a longer-term view of the product as we consider project costs.
    This can be difficult since our authority as project managers may be limited to the project boundaries, but we have to make efforts to ensure those cost decisions within the project don't have unacceptable repercussions to the total cost of ownership of the product, whether the product is for our organization or for external customers.
  • Cost of Quality
    The cost of quality is about making trade-offs between perfection and acceptable levels of quality in the product.
    We'll find out more about quality in chapter 8, but for now, we need to know what is the acceptable level of quality needed by the product and what will it cost to ensure that quality level is met.
  • Marketplace Conditions
    Market conditions over the course of the project will impact resource costs.
    Though difficult to anticipate, trends need to be factored into costs, especially for longer projects or when there are clear fluctuations occurring for project resources.
    Marketplace conditions can also be thought of as assumptions, so the logic involved should be well-documented when they're included in cost estimates.
    Another marketplace condition that factors into costs is what resources are available and at what cost.
    For example, if the resource is in high demand or scarce, the price is likely to be higher.
    There could also be only a handful of suppliers from whom a resource can be purchased from, or the organization may have an approved seller list, which limits where the resources can be procured from at what price.

Estimating Methods

Several methods help us establish reliable project costs; Expert judgment always plays a part because there are so many interrelated factors that influence costs.

  • Expert judgment relies on historical experience to assess and adjust estimates.
  • Analogous estimating uses the costs from similar projects or activities as the basis for the current project.
    As long as the two activities are similar and are occurring under similar situations this can be a fairly reliable technique.
  • Parametric estimating uses mathematical formulas to derive estimates from. It isn't applicable to all activities, but when it is it usually produces the most accurate estimates.
    For example, if it's known that a material will cost $10 per cubic meter and 100 cubic meters are needed, the estimated cost is $1,000.
  • Bottom-up estimating decomposes activities to the lowest level possible for cost estimating purposes and then aggregates component costs back up to a summary activity level.
    Bottom-up estimating can take some time to do well, and it requires specific details to be known about the activity, so it isn't generally an available option early in the project planning processes. 
  • Top-down estimating is the counterpart to bottom-up, and it estimates costs by looking only at broad, summary-level activities. Top-down estimates are the least accurate.
  • Three-point estimates, sometimes called PERT analysis, help to remove the uncertainty from estimates by providing a weighted average using the pessimistic, optimistic, and most-likely values.
    We saw this formula in chapter 6 when we were estimating activity durations:
    Cost Estimate = (Optimistic Cost Estimate + (4 x Most-Likely Cost Estimate) + Pessimistic Cost Estimate) / 6
    CE = CO + 4CM + CP / 6
Optimistic Cost Estimate
Most-Likely Cost Estimate
Pessimistic Cost Estimate

Three-point estimate = ($75 + (4 x $100) + $150) / 6
Three-point estimate = ($75 + $400 + $150) / 6
Three-point estimate = $625 / 6
Three-point estimate = $104.17

If the project involves procurement activities, vendor bid analysis may also be used to develop estimates.

  • Vendor bid analysis involves additional techniques to ensure that the bids and work they represent are accurate, reasonable, and acceptable.

Estimating Sources

Sources for analogous estimating are varied and will depend upon the project type and resources of the organization.

  • Resource Cost Rates​
    It's necessary to know the unit cost for resources, both personal and no personnel.
    Personnel rates can be found in the human resource plan or may need to be determined if the staffing processes haven't yet occurred. Contracts, commercial databases, and vendor bids will also include resource cost rates.
  • Commercial Databases​
    For some activities, tables or databases of costs can be referred to. Commercial databases provide resource rates by region or other relevant classifications.
  • Historical Information​
    Historical information within the organization is another valuable source of costs. For example, the organization may be able to provide the running average cost of attorney fees based on previous actual experience.
  • Project Files​
    Cost data may also be derived from past projects as long as sufficient supporting detail about the activity and the actual costs are accessible.
  • Lessons Learned​
    Lessons learned documents are always useful. Reviewing lessons learned might avert a cost estimating issue that was encountered by another project team.
  • Subject Matter Experts​
    Based on their past experiences, the project team and other subject matter experts can assist in providing cost data. Though this advice is helpful, it's less reliable than documented data.

Reserve Analysis

It's rare for actual costs to exactly match up with their original estimates. Technically, all cost variances stem from risks, and these can range from the risk of minor estimating errors to major risk events that have the potential to sink the project.​

Reserve analysis evaluates risks by making financial allowances for them in the project’s funding requirements.

Appropriate funding for risks is a factor in how well the project recovers from risk events should they occur. There are three general budgeting techniques for addressing financial uncertainty.

Reserve Analysis

Reserve Analysis

First, there's the potential for minor irregularities in the activity cost estimates.

There may be an insufficient detail to accurately estimate the activity cost or the activity's cost may depend on factors not yet fully explored or decisions not yet made.

For example, the activity cost may depend upon a later decision for equipment purchase between two vendors, one with a quote of $1,000 and a second with a quote of $1,300.

For these types of variances, a line-item budget allowance or budget reserve is generally made.

These types of variances are not for unexpected occurrences but are tied specifically to a line item or activity, and its use is generally preapproved, meaning that the project manager has the flexibility to use as needed for the purpose intended.

Second, every project has the potential for risk events. Those risks, their probability of occurring, and their impact on the project should they occur are quantified during risk planning.

It may be necessary to set aside costs for these "known unknowns" so that the project has the financial resources to recover should they occur.

Other risk events, such as those related to human resource scarcity can also create a need for reserve cost buffers distributed to sets of activities. Reserve funds of these types are contingency reserves, and a project may have one or more contingency reserves set aside for them.

Contingency reserves are to be used at the discretion of the project manager for the risk intended. If the risk events for which contingency reserves were established don't occur, these funds are released from the project and returned to the performing organization.

Third, there are some projects that are especially likely to have significant and unforeseen scope changes.

These could be projects with deliverables relying on new technology or projects whose deliverables are unconventional in their approach.

The impact of a major scope shift or change in the project essentially blows the project's budget, so this third type of reserve fund is intended to help re-fund a project should these types of changes occur, and it's known as a management reserve because the funds are under control of the organization's upper management and not within the project manager's control.

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